How New Tax Bill Impact Your Business?
By Ying McKee- San Francisco Tax advisor
he 2017 Tax Cuts and Jobs Act of 2017 (TCJA) is the biggest tax change I have ever seen in my career. Its impact is so vast that will impact nearly everyone in this country. Most of the provisions for individuals are temporary and many of them will expire after 8 years. However, Many of the provisions related to business are permanent. It is critical for business owners to be aware of these changes.
Corporate tax rate
Before 2018, corporate businesses are taxed with graduated rate with 35% of taxable income over 10 million. Starting 2018, corporate will be taxed at the flat rate of 21%. There will also no special tax rate for personal service corporations. Maximum net capital gain rates for the corporation was eliminated as well.
The new tax act repeals the corporate AMT. Any remaining AMT credit can be used to offset the regular tax liability and is refundable between 2018 and 2012 (with limitation).
Bonus Depreciation Deduction
Bonus depreciation under Sec.168(K) has been changed several times during the years. The tax extends the bonus depreciation to allow 100% deduction of eligible property in service after September 27, 2017, until end of 2022. Previously bonus depreciation only available for the new property. Under the TCJA, used property qualify as well. Bonus depreciation for luxury autos will be $8,000 for 2018 but will phase down in 2019.
Section 179 Expensing
The act increased the maximum amount a taxpayer may expense under Sec. 179 to $1 million. If you have over $2.5 million of qualify property, $1million dollar expensing limit starts to phase-out. Starting 2018, the qualifying property will include certain depreciable tangible personal property used predominantly to furnish lodging or in connection with furnishing lodging. It also includes improvements to nonresidential real property: roofs; heating, ventilation, and air-conditioning property; fire protection and alarm systems; and security systems. The maximum allowed depreciation for luxury auto is $10,000 for 1st year, $16,000 for the second year, $9,600 for the third year, and $5,760 for the fourth and later years.
Taxpayers that have average annual gross receipts of $25 million or less in the three prior tax years:
a. You are allowed to use cash method accounting.
b. You are allowed to treat inventories as nonincidental materials and supplies instead of account for inventory under Sec. 471.
c. you are exempted from the Uniform Capitalization Rules (UNICAP) of Section 263A.
d. Exempt from the new interest deduction limitation under the new tax act. (We will not discuss the interest deduction limitation in this article as it applies only to bigger business)
e. exempt from the requirement to use the percentage-of-completion method for certain long-term contracts (allow to use cash or completed contract method)
Net operating losses
The act limits the deduction for net operating losses (NOLs) to 80% of taxable income. Loss carryback was repealed(except for farming) and you can carry forward indefinitely.
Like-Kind Exchange Rules
Like-kind exchanges under Sec. 1031 will be limited to exchanges of real property that is not primarily held for sale. Trade in for personal property such as autos are elimitated.
Domestic production activities:
The act repeals the deduction for domestic production activities.(Sec. 199)
Under the old rule, you can deduct entertainment, amusement, or recreation that is directly related to the active conduct of the taxpayer's trade or business with 50% limitation.
The new act disallows a deduction for:
a. An activity generally considered to be entertainment, amusement, or recreation
b. Membership dues for any club organized for business, pleasure, recreation, or other social purpose
c. A facility or portion thereof used in connection with any of the above items.
Previously, under de minimis fringe benefit, the employers are allowed to deduct the expenses to provide food and beverages to employees through an eating facility if they are for the convenience of the employer. Under new tax bill, there is a 50% limitation. After December 31, 2025, none will be deductible.
In addition, the act disallow a deduction for expenses associated with providing any qualified transportation fringe to employees of the taxpayer and, except as necessary for ensuring the safety of an employee.
Changes to business credits.
There are some changes to business credits such as orphan drug credit and rehabilitation credit etc. One noticeable credit is the new act offers companies if they provide paid family and medical leave for their workers. If the company contributes at least 50% of their normal pay, it will receive a tax credit equal to 12.5 percent of the amount paid. The tax credit will increase on a sliding scale if the company pays more than 50 percent of wages. It has max 25 percent of the amount the employer paid for up to 12 weeks of leave. However, the credit only avalabiel 2018 and 2019 and only for employee earning less than 72K/year.
(6) excludes various types of self-created property from the definition of a "capital asset", including: patents, inventions, models or designs (whether or not patented), and secret formula and processes;
(7) specifies situations in which a contribution to the capital of a corporation is includable in the gross income of a corporation (i.e., contributions by a customer or potential customer, and contributions by governmental entities and civic groups); and
(8) tweaks the carried interest rule to provide that a profits interest must be held for three years, rather than one year, in order to receive favorable long-term capital gain treatment.
New Deduction for Qualified Business Income
If you are a sole proprietor, a partner in a partnership, a member in an LLC taxed as a partnership (hereafter, "partner"), or a shareholder in an S corporation, TCJA provides a new deduction for qualified business income for taxable years beginning after December 31, 2017, and before January 1, 2026. Trusts and estates are also eligible for this deduction.
The amount of the deduction is generally 20 percent of the taxpayer's qualifying business income from a qualified trade or business.
Example: In 2018, Joe receives $100,000 in salary from his job at XYZ Corporation and $50,000 of qualified business income from a side business that he runs as a sole proprietorship. Joe's deduction for qualified business income in 2018 is $10,000 (20 percent x $50,000).
The deduction for qualified business income is claimed by individual taxpayers on their personal tax returns. The deduction reduces taxable income. The deduction is not used in computing adjusted gross income. Thus, it does not affect limitations based on adjusted gross income.
The deduction is subject to several restrictions and limitations, discussed below.
Qualified Trade or Business. A qualified trade or business means any trade or business other than (1) a specified service trade or business, or (2) the trade or business of being an employee. A "specified service trade or business" is defined as any trade or business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, including investing and investment management, trading, or dealing in securities, partnership interests, or commodities, and any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees. Engineering and architecture services are specifically excluded from the definition of a specified service trade or business.
Special Rule Where Taxpayer's Income is Below a Specified Threshold. The rule disqualifying specified service trades or businesses from being considered a qualified trade or business does not apply to individuals with taxable income of less than $157,500 ($315,000 for joint filers). After an individual reaches the threshold amount, the restriction is phased in over a range of $50,000 in taxable income ($100,000 for joint filers). If an individual's income falls within the range, he or she is allowed a partial deduction. Once the end of the range is reached, the deduction is completely disallowed.
"Domestic" Business Income Requirement. Items are treated as qualified items of income, gain, deduction, and loss only to the extent they are effectively connected with the conduct of a trade or business within the United States.
Qualified Business Income. Qualified business income means the net amount of qualified items of income, gain, deduction, and loss with respect to the qualified trade or business of the taxpayer. Qualified business income does not include any amount paid by an S corporation that is treated as reasonable compensation of the taxpayer, or any guaranteed payment (or other payment) to a partner for services rendered with respect to the trade or business. Qualified items do not include specified investment-related income, deductions, or losses, such as capital gains and losses, dividends and dividend equivalents, interest income other than that which is properly allocable to a trade or business, and similar items.
Loss Carryovers. If the net amount of qualified business income from all qualified trades or businesses during the tax year is a loss, it is carried forward as a loss from a qualified trade or business in the next tax year (and reduces the qualified business income for that year).
W-2 Wage Limitation. The deductible amount for each qualified trade or business is the lesser of:
(1) 20 percent of the taxpayer's qualified business income with respect to the trade or business; or
(2) the greater of: (a) 50 percent of the W-2 wages with respect to the trade or business, or (b) the sum of 25 percent of the W-2 wages with respect to the trade or business and 2.5 percent of the unadjusted basis, immediately after acquisition, of all qualified property (generally all depreciable property still within its depreciable period at the end of the tax year).
Example: Susan owns and operates a sole proprietorship that sells cupcakes. The cupcake business pays $100,000 in W-2 wages and has $350,000 in qualified business income. For the sake of simplicity, assume the business had no qualified property and that the variation of the limitation involving the unadjusted basis of such property isn't relevant. Susan's deduction for qualified business income is $50,000, which is the lesser of (a) 20 percent of $350,000 in qualified business income ($70,000), or (b) the 50 percent of W-2 wages ($50,000).
The W-2 wage limitation does not apply to individuals with taxable income of less than $157,500 ($315,000 for joint filers). After an individual reaches the threshold amount, the W-2 limitation is phased in over a range of $50,000 in taxable income ($100,000 for joint filers).
Allocation of Partnership and S Corporations Items. In the case of a partnership or S corporation, the business income deduction applies at the partner or shareholder level. Each partner in a partnership takes into account the partner's allocable share of each qualified item of income, gain, deduction, and loss, and is treated as having W-2 wages for the taxable year equal to the partner's allocable share of W-2 wages of the partnership. Similarly, each shareholder in an S corporation takes into account the shareholder's pro rata share of each qualified item and W-2 wages.
Additional Limitations on the Deduction for Qualified Business Income. This deduction for qualified business income is subject to some overriding limitations relating to taxable income, net capital gains, and other items which are beyond the scope of this letter and will not affect the amount of the deduction in most situations.
TCJA also codifies the current deferral method of accounting for advance payments for goods and services provided by the IRS under Rev. Proc. 2004-34. That is, the law allows taxpayers to defer the inclusion of income associated with certain advance payments to the end of the tax year following the tax year of receipt if such income also is deferred for financial statement purposes.
Interest Deduction Rules Changed for Certain Taxpayers
Employer Credit for Paid Family and Medical Leave
For 2018 and 2019, TCJA allows eligible employers to claim a general business credit equal to 12.5 percent of the amount of wages paid to qualifying employees during any period in which such employees are on family and medical leave if the rate of payment under the program is 50 percent of the wages normally paid to an employee. The credit is increased by 0.25 percentage points (but not above 25 percent) for each percentage point by which the rate of payment exceeds 50 percent.
Observation: An employer must have a written policy in place that provides family and medical leave to all employees on a non-discriminatory basis in order to qualify for the credit. Given the cost of implementing such a policy and complying with yet-to-be-announced reporting requirements, the credit may be impractical for many employers to pursue during the short period it's available. For companies that already have a qualifying family and medical leave plan in place, however, the credit may provide a nice windfall.
Partnership Rule Changes
Several changes were made to the partnership tax rules.
First, gain or loss from the sale or exchange of a partnership interest is treated as effectively connected with a U.S. trade or business to the extent that the transferor would have had effectively connected gain or loss had the partnership sold all of its assets at fair market value as of the date of the sale or exchange. Any gain or loss from the hypothetical asset sale by the partnership is allocated to interests in the partnership in the same manner as nonseparately stated income and loss.
Second, the transferee of a partnership interest must withhold 10 percent of the amount realized on the sale or exchange of the partnership interest unless the transferor certifies that the transferor is not a nonresident alien individual or foreign corporation.
Third, TCJA modifies the definition of a substantial built-in loss such that a substantial built-in loss is considered to exist if the transferee of a partnership interest would be allocated a net loss in excess of $250,000 upon a hypothetical disposition by the partnership of all partnership's assets in a fully taxable transaction for cash equal to the assets' fair market value, immediately after the transfer of the partnership interest.
Fourth, TCJA modifies the basis limitation on partner losses to provide that a partner's distributive share of items that are not deductible in computing the partnership's taxable income, and not properly chargeable to capital account, are allowed only to the extent of the partner's adjusted basis in its partnership interest at the end of the partnership taxable year in which an expenditure occurs. Thus, the basis limitation on partner losses applies to a partner's distributive share of charitable contributions and foreign taxes. Lastly, TCJA repeals the rule providing for technical terminations of partnerships. Under that rule, a partnership's existence did not necessarily end; rather, it resulted in the termination of some tax attributes and the possibly early closing of the tax year.
S Corporation Changes
TCJA makes several changes to the tax rules involving S corporations. First, it provides that income that must be taken into account when an S corporation revokes its election is taken into account ratably over six years, rather than the four years under prior law. Second, it allows a nonresident alien individual to be a potential current beneficiary of an electing small business trust (ESBT). Third, it provides that the charitable contribution deduction of an ESBT is not determined by the rules generally applicable to trusts but rather by the rules applicable to individuals. Thus, the percentage limitations and carryforward provisions applicable to individuals apply to charitable contributions made by the portion of an ESBT holding S corporation stock.
International Tax Changes
TCJA makes sweeping changes to the Unites States' international tax regime through a series of highly complex provisions that are beyond the scope of this letter.
Dividends Received Deduction
A corresponding change reduces the 70 percent dividends received deduction available to corporations that receive a dividend from another taxable domestic corporation to 50 percent, and the 80 percent dividends received deduction for dividends received from a 20 percent owned corporation to 65 percent.
As you can see, the provisions in the TCJA are quite extensive and also quite complicated.
Please call me at your convenience so we can discuss how these changes will impact your business, and what kind of strategies we can adopt to ensure that your business gets the best possible tax outcome under the new rules.
Call Ying, your trusted Virtual CPA if you have further questions.
If you want to read the full text of the bill, you can find it here
Circular 230:The articles are for general information only. In accordance with IRS Circular 230 they are not considered tax opinions for purposes of relying on such statements in any challenge of the reporting of the above transaction by the IRS. If a full tax opinion is required certain procedures must be met . Also there is a significant cost for a full tax opinion to meet the requirements of Circular 230.